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Chapter 4
Valuation of Shares
Meaning of valuation of shares
The term valuation of shares refers to the process of ascertaining the market value of fair
value of shares of the company
The various circumstances necessitating valuation of shares are:
 When amalgamation or absorption of companies
 When a block of shares are purchased or sold
 When one class of shares are converted into another class
 When a company is nationalised
 When shares are to be provided as a security for loans and advances
 When shares are to be sold in the absence of stock exchange

Factors influencing the value of the shares:

 The nature of business
 Stability of earning of the company
 The earning capacity of the company
 Capacity of management of the company
 The demand for and supply of shares of the company
 The economic and political conditions in the country
 The value of goodwill of the company
 The progress of the company
 The nature of the competition

Methods of valuations of shares:

1. Net asset method/asset backing method/Intrinsic value method
2. Yield method
3. Fair value method
4. Earning capacity method

NET Asset method

Under this method, value of shares is determined by adding the market value of all the
assets including unrecorded assets, goodwill and investments and deducting total
liabilities payable to outsiders i.e secured and unsecured loans and current liabilities

PROFORMA FOR CALCULATING INTRINSIC VALUE PER SHARE

“STRENGTH IS THE PRODUCT OF STRUGGLE YOU MUST DO WHAT OTHERS DON’T, TO ACHIEVE
WHAT OTHERS WON’T”
 Particulars Amount Amount

2 Market value of assets ( Except fictitious assets like

preliminary expense, underwriting commission, discount on
issue of shares, P/L debit balance)
Goodwill Xxx
L/B Xxx
Furniture Xxx
Patents and trade mark Xxx
Motor vehicle Xxx
Investments Xxx
Cash in hand Xxx
Cash at bank Xxx
Sundry debtors Xxx
Bills receivable Xxx
Stock in trade Xxx
Prepaid expenses xxx xxxx

Less: External Liabilities

Debentures xxx
Mortgage loans xxx
Unsecured loans xxx
Fixed deposits from public xxx
Sundry creditors xxx
Bills payable xxx
Bank overdraft xxx
Unclaimed dividend xxx
Provision for taxation xxx
Proposed dividend xxx
Employees PF xxx
Depreciation fund xxx

Assets Available to both share holders xxxx

Less: Amounts payable to preference shareholders:

a) Arrears of PD xxx
b)Preference share capital xxx
xxxx
Net value of assets available for equity shareholders xxxxx

Intrinsic value of equity share=Net value of assets available for equity shareholders
Number of equity shares

“STARVE YOUR DISTRACTIONS, FEED YOUR FOCUS”

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Problems:
1. From the following information calculate the intrinsic value of Company
Plant and Machinery 50, 000
Land and Building 70, 000
Motor Car 30, 000
Debtors 100, 000
Creditors 10, 000
Bills Payable 20, 000
BOD 5, 000
2, 000 equity shares of Rs 10 Each 20, 000

2. Following is the balance sheet of C and C ltd. as on 31st march 2015

Assets Amount Amount
Fixed Assets:
L/B 150,000
Machinery 100,000
Investments at cost 45,000
(market value Rs.40,000)
Debtors 100,000
Stock 40,000
Cash 10,000
TOTAL 445,000
Liabilities Amount Amount
Capital
3,000 shares of Rs.100 each 300,000
General reserve 50,000
P/L a/c 25,000
Creditors 40,000
Provision for taxation 20,000
Provident fund 10,000
TOTAL 445,000
Additional information:
a. Goodwill is taken at Rs.50, 000
b. depreciation machinery @ 10 % and Increase land and building to Rs.180,000
c. Provide 8% towards for bad debt
d.20% dividend declared for the current year
Calculate the intrinsic value of shares of the company.

“Live as if you die tomorrow, learn as if you were live forever ”

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3. Following is the balance sheet of Max col. Ltd as on 31.03.2013

Liabilities Amount Asset Amount
Share capital: Fixed asset 400,000
1000, 8% preference shares of Current asset 250,000
Rs.100 each 100,000 Preliminary expense 20,000
30,000 equity shares of Rs 10 300,000 Discount on Issue of 5,000
each 100,000 debenture 45,000
Debenture 6% 50,000 Profit and loss acc
Debenture redemption fund 100,000
Depreciation Fund 70,000
Sundry creditors
720,000 720,000

Calculate the value of the equity share under net asset method after considering the
following:
a. Debenture interest due for 1 year
b. Current assets include Book debts of which Rs.12, 000 which were doubtful for which no
provision has been made.
c. When preference share is given priority, calculate the intrinsic value of shares

4. On 31.3.2002 the balance sheet of Sachin co ltd. was as follows

Liabilities Amount Assets Amount
Share capital Land and building 220,000
Authorised and P/M 95,000
issued 5,000 equity Stock 350,000
shares of Rs.100 500,000 Sundry debtors 155,000
each fully paid 103,000
P/L a/c 20,000
Bank overdrafts 77,000
Creditors 45,000
Provision for 75,000
Taxation
Proposed dividend

820,000 820,000
The net profits of the company after deducting all working charges and providing for
depreciation and taxation were as under:
1997-85,000 1998-96,000 1999-90,000 2000-100,000 2001-95,000
On 31.3.2002 land and building were valued at 250,000 and plant machinery at Rs.150, 000
In the view of the nature of the business, it is considered that 10% is a reasonable return on
capital employed. For the purpose of valuation of shares, goodwill is calculated at 5 years
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purchase of the super profits based on the average profits of last 5 years. Calculate the
intrinsic value of shares
5. ( when net asset apportioned according to paid up capital ratio)
The following is the balance sheet of Baskins trading co.
Liabilities Amount Assets Amount
2,000 6% preference 300,000 Fixed assets 300,000
shares of Rs.100 Current assets 300,000
each
30,000 equity shares 300,000
of Rs 10 each 100,000
Liabilities
600,000 600,000

The market value of fixed assets is 10% more than the book value. The market value of current
assets is 5% less than book value. There is an unrecorded liabilities of Rs.5, 000. You are
required to calculate value of Shares.
6. ( when party paid shares are given)
Following is the Balance sheet of Mr.Shurakshith ltd. as on 31 march 2013
Liabilities Amount Assets Amount
Share capital Fixed assets:
30,000 equity shares of Rs.20 Goodwill 25,000
each fully paid 600,000 Building 600,000
25,000 equity shares of Rs.20. Machinery 375,000
Rs.8 paid 200,000
15,000 equity shares of Rs.10 Investments 50,000
each fully paid 150,000
10,000 equity shares of Rs.10 Current assets
each. Rs.5 paid 50,000 Stock 300,000
Reserves and surplus Debtors 150,000
General reserve 450,000 Bills receivable 50,000
Profit and loss account 50,000 Bank 130,000
Current liabilities
Creditors 200,000 Miscellaneous expenses
Discount on issue of shares 20,000
17,00,000 17,00,000

Goodwill is valued at 15,000, buildings at 12, 00, 000, machinery at Rs.300, 000. Investments
at Rs.35, 000, stock at 250,000, Debtors at 140,000. There was a contingent liability of Rs.20,
000

“You are not defeated until you are defeated within”

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7. (When there is no differences in the face value of equity and preference shares)
The following is balance of Syed ltd as on 31 march 2002
Liabilities Amount Asset Amount
Share capital Sundry assets 510,000
10,000, 6% Discount on
preference shares of debentures 10,000
Rs.10 each fully 100,000 Preliminary 30,000
paid expenses 60,000
30,000 ordinary Profit and loss A/c
shares of Rs.10 each, 300,000
fully paid
Debenture 30,000
redemption fund 50,000
7% debenture 30,000
Depreciation fund 100,000
Sundry creditors
610,000 610,000

The sundry assets worth Rs.525, 000. One year’s interest if owing on debenture and the
dividends on preference shares are in arrears for two years. You are required to value the
shares on the Net assets method,. If
a) Preference shares have priority both to the payment of capital and arrears of dividend, in
the event of liquidation.
b) Preference shares have no priority as to capital or arrears of dividend
c) Preference shares have priority as to payment of capital only
d) Preference share have priority as to the payment of arrear of dividend only

“Life is a teacher and you are in state of Constant Learning”

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YIELD METHOD:
Under this method instead of considering market values of assets and liabilities this method
takes into consideration the profits available for equity dividend and expected returns and
normal returns are compared
Steps to calculate value of shares under yield method:
Step 1
Calculate Average profits on basis of data available
Step 2
Calculate profits available for dividend after deducting the provision for tax and various
apportions towards reserves
Step 3
Calculate profits available to equity shareholders by deducting the dividends payable to
preference share holders
Step 4
Calculate expected rate of return by using the following equation:
Expected rate of return=Profit available to equity shareholder X 100
Equity capital
Step 5
Value of shares = Expected rate of return X 100
Normal rate of return

Problems:
1. From the following information, calculate the value of an equity share under yield method.
a. The paid up share capital of a company consists of 1000, 15% preference shares of Rs.100
each and 20,000 equity shares of Rs.10 each.
b. The average annual profit of the company, after providing for depreciation and taxation
amounted to Rs.75, 000. It is considered necessary to transfer Rs.10, 000 to general Reserve
before declaring dividend
c. The normal return expected by investors on equity shares from this type of business carried
on by the company is 10%

“Knowledge give you power, Character gives you respect”

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2. Mahi products Pvt ltd is feeling pressure of fighting off the giant multinationals in the
automobiles industry. However Mr. Dravid the founder of the company would like to relieve
himself of the tensions of running the company.
In order to negotiate with prospective buyers, he would like to know the value of shares
of the company on the basis of the following information.
Liabilities Amount Asset Amount
1.Equity and 1)Noncurrent asset
liabilities a)Fixed assets
a)Share capital Land and building 70,000
10,000 Equity shares !00,000 Plant & Machinery 70,000
of Rs.10 each Trade marks 20,000
b)Reserves and
surplus 43000 2)Current Asset
General reserve 30000 Stock 20,000
Surplus Debtors 48,000
Cash at Bank 25,000
Current liabilities: 40000
Sundry creditors 20000
Workmen’s saving 20000
a/c
Taxation Reserve
TOTAL 253,000 TOTAL 253,000

Plant and machinery is worth Rs.60, 000 and land building are worth Rss.130, 000 as valued
by independent valuer. Rs.5, 000 of the debtors is to be taken as bad. The profits of the company
were
2012-13=50,000 2013-14=60,000 2014-15=70,000
It is the practice of the company to transfer 20% of the profits to reserve. Shares of similar
companies quoted in the stock exchange yield 12% of the market value. Goodwill of the
company may be taken at Rs.100, 000
Calculate the value of shares under yield method.
3.The profit of a XYZ co. for the year ended 31st march 2015 were 60,00,000.After setting
apart amounts for interest on borrowings, taxation and other provisions, the net profits
available to shareholders is estimated at Rs.15,00,000. The company capital base consisted
of:
a) 100, 000 equity shares of Rs.100 each, Rs.50 per share paid up
b) 25, 000 12% preference shares of Rs.100 each, fully paid
Enquires in the stock market reveal that shares of companies engaged in similar business and
declaring dividend of 15% on equity share are quoted at a premium of 10%. What do you
expect the market value of the company’s share to be, basing your working on the yield
method?
“Set your goals high enough to inspire you and low enough to encourage you”
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4. From the following balance sheet as on 31st march, 2015 of RISWAN co ltd. Compute the
value of equity shares by rate of earning basis(Yield method)
Liabilities Amount Asset Amount
Equity share of Fixed asset 500,000
Rs.10 each fully 250,000 Current asset 300,000
paid 75,000
Reserves and surplus 250,000
Debentures 225,000
Other liabilities
TOTAL 800,000 TOTAL 800,000

YEAR 2010-11 2011-12 2012-13 2013-14 2014-15

Sales 600,000 700,000 800,000 500,000 900,000
Operating cost 345,000 395,000 445,000 295,000 495,000
Interest on 25,000 25,000 25,000 25,000 25,000
loan

Assume rate of taxation at 60% and rate of normal earnings at 12.5%. Show the working also.

Fair value method

Many accountants are of the view that neither the net assets basis nor yield basis of
valuation of shares is correct, but the fair valuation method may be an average of the
two methods of valuation of shares.
Fair value=Value of shares on net assets basis + Value of shares on yield basis
2
1. From the following particulars, calculate the fair value of an equity shares assuming that
out of total assets, those amounting to Rs.41, 00, 000 are fictitious
a. Share capital
550,000 10% preference shares of Rs.100 each
55, 00,000 Equity shares of Rs.10 each
b. liabilities to outsiders Rs.75, 00,000
c. Reserves and surplus Rs.45, 00,000
d. The average normal profit after taxation earned every year by the company during the last
five years, Rs.85, 05,000
e.The normal profit earned on the market value of fully paid shares of similar company is
12%

“A GOAL WITHOUT PLAN IS DREAM”

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Earning capacity method:

Sometimes, the rate of dividend declared by a company is much less than the rate of earnings
of the company because of accumulated losses and retention of profits.
Under this method the shares are valued on the basis of earning capacity of the firm. The
earning capacity of the firm.
The earning capacity is determined by considering the profits earned as a percentage
to the capital employed
Steps:
Step 1: Calculation of rate of earnings.
Rate of earning=Average annual profits X 100
Capital employed

Step 2: Calculation of value of each shares

Value of each share=rate of earnings x 100
Normal rate of Returns

Problems:1
From the following information calculate the value of share under earning capacity method
Capital employed Rs.500, 000
Average annual profit Rs.60, 000
Normal rate of returns=10%
2. The following is the balance sheet of SHIKAR co ltd. as on 31st march 2002
Liabilities Amount Assets Amount
Equity capital of Rs 10 Fixed assets 500,000
each 400,000 Current assets 200,000
Reserve 90,000 Goodwill 40,000
P/L a/c 20,000
5% debenture 100,000
Current liabilities 130,000
TOTAL 740,000 TOTAL 740,000

On March 31, 2002 the fixed assets were independently valued at Rs.350, 000 and goodwill at
Rs.50, 000. The Net profits of the three years were 2000-51,600; 2001-52,000 and 2002-52650.
Compute the value of shares under earning capacity method.
“S’U’CCESS DEPENDS ON SECOND LETTER”
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2. The following is the balance sheet of Patel co ltd. as on 31st march 2002
Liabilities Amount Assets Amount
Equity capital of Rs 10 Fixed assets 10,00,000
each 800,000 Current assets 400,000
Reserve 180,000 Goodwill 80,000
P/L a/c 40,000
5% debenture 200,000
Current liabilities 260,000
TOTAL 14,80,000 TOTAL 14,80,000

On March 31, 2002 the fixed assets were independently valued at Rs.700, 000 and goodwill at
Rs.100, 000. The Net profits of the three years were 2000-103,200; 2001-104,000 and 2002-
105,300 .of which 40% was placed under reserve, this proportion being considered reasonable
in the industry in which the company is engaged and where the fair investment return may be
taken at 10%. Compute the value of company shares under a) Net asset b)Yield method c)Fair
value method and d)Earning capacity method.
RIGHT ISSUE:
Subsequent issue of shares by an existing company to existing shareholders are known as
right issue. This share is issued at the price lower than the market price of the share.
Advantages of right issue
1. Control is retained with the existing share holders
2. The existing shareholders do not suffer on account of dilution in value of their shares
3. The expenses to be incurred, if shares are offered to general public is avoided
4. Image of the company is bettered
5. More certainty of getting capital
6. Directors cannot misuse the opportunity
Formula for calculating right value’
R=M-S
N+1
R=Value of one right issue
M=cum right market price of a share
S=Subscription price or issue price for a new share
N=Number of old shares required to purchase one right share
Cum-right price-Gives the purchaser, besides the ownership of the shares already held, right
to apply for new shares offered by the company.

“Fear kills more dreams than failures”

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Ex-right price- gives the purchaser only the ownership of the existing shares held by the
seller and not right to apply for additional shares offered by the company.
Problems:
1. A company is planning to raise funds by making rights issue of equity shares to finance its
expansion. The existing equity share capital of the company is Rs.50, 00,000. The market value
of its shares is 42. The company offers to its shareholders the right to buy 2 shares at Rs.11
each for every 5 shares held. You are required to calculate.
a) The value of the right
b) Ex-right value of the share
2. Nithin co.ltd decided to make rights issue in the proportion of one new shares of Rs.200 each
at a premium of Rs.50 each to the shareholders for every three existing shares. The market
value of the shares at the time of announcement of right issue is Rs.500 each. You are required
to calculate.
a) The value of the right
b) Ex-right value of the share.

“Money doesn’t buy Happiness, but lack of money buys you Misery”